Consulting for Equity: A Strategic Approach for Entrepreneurs and Consultants

Startup equity isn't just for founders, employees, and investors. Consultants and entrepreneurs working with start-ups can get an equity stake and more potential upside too.
Written by
Kim Le
Published on
June 4, 2024

What is Equity and How Does it Work?

Equity represents a share of ownership in a company. For startups, equity is often used as a compensation model, particularly when cash is scarce. This common practice allows startups to attract top talent and expertise by offering a stake in the company's future success.

A famous example is the graffiti artist who painted the murals at Facebook's headquarters in exchange for equity. At the time, the company couldn’t afford his services in cash. When Facebook went public, this equity turned into millions of dollars, showcasing the potential for significant returns through equity compensation.

Why Consult for Equity?

1. Teams Without Capital

Sometimes, the most promising projects lack immediate capital but offer immense potential. By working for equity, consultants can engage with projects they are passionate about and teams they believe in, without working for free. Non-cash compensation aligns the interests of both parties and can be a powerful motivator.

2. Building a Start-up Portfolio

Consulting for equity mimics the approach of an investor, where instead of providing capital, you provide your expertise. Serving as an advisor to start-up founders can yield substantial rewards if the start-up succeeds. However, it's important to recognize that nine out of ten start-ups fail. Building a diversified portfolio of equity stakes increases the chances of benefiting from the successes, akin to playing the numbers game.

3. Betting on the Small Guys Winning

Supporting emerging companies can be a strategic move. Early-stage start-ups are often more accessible due to their limited resources. As these companies grow, they can become substantial clients, offering potentially lucrative and loyal business relationships. This “land and expand” model is a common sales approach in software that ties naturally to consulting with start-ups. Consulting for equity allows you to bet on the potential of these small players to achieve significant success.

How to Start Consulting for Equity?

1. Assess the Target Client

Before entering into an equity agreement, it's crucial to evaluate the potential client. Key considerations include:

  • Is the company a C-Corp?
  • Is it venture-backed?
  • Does it manage its cap table with a system like Carta or Cake Equity?
  • Is it advised by a corporate law firm specializing in tech?

These factors can indicate the stability and growth potential of the company. You'll want to make sure that the company in question answers "yes" to all four questions before considering taking equity. In particular, ensuring it works with a good law firm is important. The firm will likely be managing the process of issuing grants and exercising options. All of this will become important when tax time comes around.

2. Test the Waters for Appetite

Introducing the idea of equity compensation should be done carefully. During compensation negotiations, gently broach the topic without appearing too forceful. Some companies may be protective of their equity, and pushing too hard could hinder discussions.

Tip #1: One way to include the ask is by suggesting an equity for cash swap. Companies may not be in a position to pay you your rate, so suggesting a lower cash compensation for equity may be a good alternative to provide for potential clients.

Tip #2: Restate the engagement in a more advisory role. From there, point to examples of company founders having board advisors who are compensated in equity. The Founder’s Institute has a good article and some templates on this topic.

3. Build the Ask Into the Engagement

Ensure that any equity agreement is clearly documented. Verbal agreements are insufficient, especially given the complexities of equity. Elements such as the grant date, strike price, and types of grants must be specified, as they have significant tax implications if the equity gains value.

You should get:

  1. The initial agreement in email form, especially if legal matters will take longer to iron out.
  2. A full executed contract between both entities with the appropriate dates and correct amounts of shares issued, and type of equity
  3. Options granted through Carta or similar platform. Review all terms and conditions and save the information for later.
  4. Ask if Form 83B applies here with the company’s legal counsel.

What to Consider When It Comes to Equity Compensation?

1. Non-Qualified Stock Options (NSOs)

NSOs are a common form of equity compensation for consultants. If you’ve only been an employee, then ISOs and RSUs will likely be more familiar terms.

NSOs grant the right to purchase shares at a predetermined price and are subject to specific tax rules. Understanding how NSOs work is essential for evaluating their potential benefits. Stock options is complicated and getting familiar with general start-up equity is a good starting point.

2. A Percent of the Company

If a company is not far enough along to issue shares, negotiating for a percent of the company can be a viable option. This approach ensures that you have a stake in the company's growth and success from the outset. Some example percentages by company growth stage and level of involvement can be found here.

3. Tax Considerations

Equity compensation comes with various tax implications. For instance, NSOs may be taxed as ordinary income upon exercise and as capital gains upon sale. It's crucial to understand these implications to make informed decisions and avoid unexpected tax liabilities.

4. Understand the Downside Risks

Equity compensation is not without risks. There is always the possibility that the equity could become worthless if the company fails. Being aware of these risks and weighing them against the potential rewards is essential for making sound decisions.

Ending Thoughts: Potential ROI

Consulting for equity presents a unique opportunity to participate in the growth of innovative companies. While it comes with risks, the potential for substantial returns can make it a worthwhile strategy for those who are knowledgeable and strategic in their approach. By carefully selecting clients, negotiating fair terms, and understanding the intricacies of equity compensation, consultants can build a diverse portfolio that leverages their expertise for significant financial gain.

For entrepreneurs and consultants alike, consulting for equity offers a pathway to align with visionary projects and potentially reap significant rewards. With the right strategy, consulting for equity can transform your career and financial future

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